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Elasticity of Market Supply:The Industry’s Long-Run Supply Curve

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Microeconomics ­ECO402
VU
Lesson 26
The Industry's Long-Run Supply Curve
Long-Run Elasticity of Supply
1) Constant-cost industry
·  Long-run supply is horizontal
·  Small increase in price will induce an extremely large output increase
·  Long-run supply elasticity is infinitely large
·  Inputs would be readily available
2) Increasing-cost industry
·  Long-run supply is upward-sloping and elasticity is positive
·  The slope (elasticity) will depend on the rate of increase in input cost
·  Long-run elasticity will generally be greater than short-run elasticity of supply
The Industry's Long-Run Supply Curve
Question:
­ Describe the long-run elasticity of supply in a decreasing -cost industry.
The Long-Run Supply of Housing
Scenario 1: Owner-occupied housing
­ Suburban or rural areas
­ National market for inputs
Questions
­ Is this an increasing or a constant-cost industry?
­ What would you predict about the elasticity of supply?
Scenario 2: Rental property
­ Urban location
­ High-rise construction cost
Questions
­ Is this an increasing or a constant-cost industry?
­ What would you predict about the elasticity of supply?
The Industry's Long-Run Supply Curve
The Effects of a Tax
­ In an earlier chapter we studied how firms respond to taxes on an input.
­ Now, we will consider how a firm responds to a tax on its output.
126
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Microeconomics ­ECO402
VU
Effect of an Output Tax on a Competitive Firm's Output
Price
MC2 = MC1 + tax
The firm will
MC
reduce output to
($ per
An output tax
the point at which
unit of
raises the firm's
the marginal cost
output)
marginal cost by the
plus the tax equals
amount of the tax.
the price.
t
P
AVC
AVC
q
q
Output
Effect of
an
Output Tax on Industry Output
Price
S2 = S1 + t
($ per
unit of
S
output)
t
P
Tax shifts S1 to S2 and
P
output falls to Q2. Price
increases to P2.
D
Q
Q
Output
Evaluating
the Gains & Losses from Government Policies:
Consumer & Producer Surplus
Review
­ Consumer surplus is the total benefit or value that consumers receive beyond what
they pay for the good.
­ Producer surplus is the total benefit or revenue that producers receive beyond what it
cost to produce a good.
127
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Microeconomics ­ECO402
VU
Price
Consumer
Surplus
S
5
Between 0 and Q0
producers receive
Producer
a net gain from
Surplus
selling each product--
producer surplus.
D
0
Q
Quantity
Consumer
To determine the welfare effect of a governmental policy we can measure the gain or loss in
consumer and producer surplus.
Welfare Effects
­ Gains and losses caused by government intervention in the market.
Suppose the government
imposes a price ceiling Pmax
Price
which is below the
Market-clearing price P0.
S
Deadweight
The gain to consumers is
the difference between
the rectangle A and the
triangle B.
B
P0
C
A
The loss to producers is
the sum of rectangle A and
Pmax
triangle C. Triangle
B and C togethermeasure
the deadweight loss.
D
Q1
Q0
Q2
Quantity
Change
in
consumer & producer surplus from price controls
Observations:
­ The total loss is equal to area B + C.
­ The total change in surplus = (A - B) + (-A - C) = -B - C
­ The deadweight loss is the inefficiency of the price controls or the loss of the producer
surplus exceeds the gain from consumer surplus.
128
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Microeconomics ­ECO402
VU
Observation
­ Consumers can experience a net loss in consumer surplus when the demand is
sufficiently inelastic
Effect of Price Controls When Demand Is Inelastic
If demand is sufficiently
inelastic, triangle B can
D
Price
be larger than rectangle
A and the consumer
suffers a net loss from
S
price controls.
P0
C
Example
A
Pmax
Oil price controls
and gasoline shortages
Quantity
Q2
Q1
Price
($/mcf)
D
S
The gain to consumers
is
2.4
rectangle A minus
triangle B, and the loss
B
to
2.0
producers is rectangle
A
A plus triangle C.
C
(Pmax)1.0
30 Quantity (Tcf)
0
5
15 1
10
20
25
Price Controls and Natural Gas Shortages
129
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Microeconomics ­ECO402
VU
The Efficiency of a Competitive Market
When do competitive markets generate an inefficient allocation of resources or market
failure?
1) Externalities
·  Costs or benefits that do not show up as part of the market price (e.g. pollution)
2) Lack of Information
·  Imperfect information prevents consumers from making utility-maximizing decisions.
Government intervention in these markets can increase efficiency.
Government intervention without a market failure creates inefficiency or deadweight loss.
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Table of Contents:
  1. ECONOMICS:Themes of Microeconomics, Theories and Models
  2. Economics: Another Perspective, Factors of Production
  3. REAL VERSUS NOMINAL PRICES:SUPPLY AND DEMAND, The Demand Curve
  4. Changes in Market Equilibrium:Market for College Education
  5. Elasticities of supply and demand:The Demand for Gasoline
  6. Consumer Behavior:Consumer Preferences, Indifference curves
  7. CONSUMER PREFERENCES:Budget Constraints, Consumer Choice
  8. Note it is repeated:Consumer Preferences, Revealed Preferences
  9. MARGINAL UTILITY AND CONSUMER CHOICE:COST-OF-LIVING INDEXES
  10. Review of Consumer Equilibrium:INDIVIDUAL DEMAND, An Inferior Good
  11. Income & Substitution Effects:Determining the Market Demand Curve
  12. The Aggregate Demand For Wheat:NETWORK EXTERNALITIES
  13. Describing Risk:Unequal Probability Outcomes
  14. PREFERENCES TOWARD RISK:Risk Premium, Indifference Curve
  15. PREFERENCES TOWARD RISK:Reducing Risk, The Demand for Risky Assets
  16. The Technology of Production:Production Function for Food
  17. Production with Two Variable Inputs:Returns to Scale
  18. Measuring Cost: Which Costs Matter?:Cost in the Short Run
  19. A Firm’s Short-Run Costs ($):The Effect of Effluent Fees on Firms’ Input Choices
  20. Cost in the Long Run:Long-Run Cost with Economies & Diseconomies of Scale
  21. Production with Two Outputs--Economies of Scope:Cubic Cost Function
  22. Perfectly Competitive Markets:Choosing Output in Short Run
  23. A Competitive Firm Incurring Losses:Industry Supply in Short Run
  24. Elasticity of Market Supply:Producer Surplus for a Market
  25. Elasticity of Market Supply:Long-Run Competitive Equilibrium
  26. Elasticity of Market Supply:The Industry’s Long-Run Supply Curve
  27. Elasticity of Market Supply:Welfare loss if price is held below market-clearing level
  28. Price Supports:Supply Restrictions, Import Quotas and Tariffs
  29. The Sugar Quota:The Impact of a Tax or Subsidy, Subsidy
  30. Perfect Competition:Total, Marginal, and Average Revenue
  31. Perfect Competition:Effect of Excise Tax on Monopolist
  32. Monopoly:Elasticity of Demand and Price Markup, Sources of Monopoly Power
  33. The Social Costs of Monopoly Power:Price Regulation, Monopsony
  34. Monopsony Power:Pricing With Market Power, Capturing Consumer Surplus
  35. Monopsony Power:THE ECONOMICS OF COUPONS AND REBATES
  36. Airline Fares:Elasticities of Demand for Air Travel, The Two-Part Tariff
  37. Bundling:Consumption Decisions When Products are Bundled
  38. Bundling:Mixed Versus Pure Bundling, Effects of Advertising
  39. MONOPOLISTIC COMPETITION:Monopolistic Competition in the Market for Colas and Coffee
  40. OLIGOPOLY:Duopoly Example, Price Competition
  41. Competition Versus Collusion:The Prisoners’ Dilemma, Implications of the Prisoners
  42. COMPETITIVE FACTOR MARKETS:Marginal Revenue Product
  43. Competitive Factor Markets:The Demand for Jet Fuel
  44. Equilibrium in a Competitive Factor Market:Labor Market Equilibrium
  45. Factor Markets with Monopoly Power:Monopoly Power of Sellers of Labor